Takeaways

The Department of Labor published a Final Rule raising the minimum salary for “white-collar” exemptions from $23,660 to $35,568 annually as of January 1, 2020, similar to the level proposed in March 2019.
The DOL, however, adopted a much smaller jump to the minimum annual compensation for the highly compensated exception, increasing it only from $100,000 to $107,432, instead of to the previously proposed $147,414.
An estimated 1.3 million exempt employees will become non-exempt under the new levels. Employers now have less than three months to prepare for this upcoming change.

On September 24, 2019, the U.S. Department of Labor (DOL) issued its much-anticipated Final Rule amending the federal Fair Labor Standards Act (FLSA) regulations for exemptions from overtime pay requirements for so-called “white-collar” exemptions. By January 1, 2020, employers will need to ensure that their workforces are properly classified in accordance with the Final Rule, which will increase the minimum salary required for an employee to be considered exempt from overtime.

Background

The FLSA mandates that employers pay employees a minimum hourly wage and also pay premium overtime at 1.5 times the employee’s regular rate for all hours worked over 40 in a work week, unless the employees are classified as exempt from these requirements. Executive, administrative, and professional employees may be classified as exempt from the FLSA’s requirements (the EAP exemption) if they meet three tests: (1) the employee must be paid a predetermined and fixed salary that is not subject to reduction because of variations in the quality or quantity of work performed (the “salary basis test”); (2) the amount of salary paid must meet a minimum specified amount, currently set at $455 per week (or $23,660 annually) (the “salary level test”); and (3) the employee’s job duties must primarily involve executive, administrative or professional duties as defined by the regulations (the “duties test”). For an employee to qualify for the Highly Compensated Employees (HCE) exemption, the employee (1) must earn a total annual compensation at or above a certain higher threshold (currently $100,000), which includes payment on a salary basis of at least the EAP-level minimum guarantee; (2) must have primary duties that include performing office or non-manual work; and (3) must customarily and regularly perform at least one of the exempt duties of an EAP exempt employee.

The Obama Administration had previously published a regulation that would have more than doubled the minimum salary level for the EAP exemption, would have increased the minimum compensation for the HCE exemption by a third, and would have instituted further automatic increases every three years (the “2016 Final Rule”). On November 22, 2016, just nine days before that regulation would have become effective, a U.S. District Court in Texas issued a nationwide preliminary injunction against enforcement of the 2016 Final Rule, followed by a permanent injunction on August 31, 2017.

The 2019 Final Rule

The Trump Administration has now published new final regulations that raise the minimum salary levels by a more modest amount, which it believes reflects growth in wages and salaries and the differing ways in which employers compensate their workforces while maintaining the traditional purposes of the salary level test and assisting employers to more readily identify exempt employees.

In the 2019 Final Rule, the DOL formally rescinds the 2016 Final Rule. In what it touts as a “common-sense approach,” the DOL sets the standard salary level by applying the methodology from the 2004 Final Rule—when the EAP levels were first set—to current wage data, resulting in a new standard salary level for the EAP exemption of $35,568 annually. The DOL also decided to increase the HCE exemption to $107,432, setting the annual compensation amount at the 80th percentile of full-time salaried workers nationwide—a level far less than the previously proposed $147,414 annual level. The DOL estimates that, under this change, 1.3 million currently exempt employees will become eligible for overtime pay.

Key Provisions of the Final Rule

The 2019 Final Rule increases the minimum salary required for the EAP exemption from $455 per week or $23,660 annually to $684 per week or $35,568 annually, calculated based on the 20th percentile of wages for full-time salaried employees in the lowest-wage region and/or in the retail industry nationally. The 2016 Final Rule, by contrast, set the standard level at approximately the 40th percentile. The DOL notes in the Final Rule that this new salary level will maintain “the prominence of the duties test,” but will also ensure that salary level alone does not render non-exempt a substantial number of employees who otherwise meet the duties test. 

Employers are allowed to use nondiscretionary bonuses and incentive payments (including commissions) to satisfy up to 10 percent of the minimum salary required for the EAP exemption, provided these payments are made on an annual or more frequent basis. This effectively reduces the minimum weekly salary payments to EAP employees to $615.60, provided that on an annual basis the employee’s total nondiscretionary compensation is at least $35,568. This element was introduced in the 2016 Final Rule, provided bonuses were paid at least quarterly. The Trump Administration has retained it with additional leniency on the timing of bonus payments, noting that this provision “appropriately modernizes the regulations” to account for the nondiscretionary bonuses and incentives that have become increasingly common in the workplace. For the HCE exemption, however, employees must be paid a guaranteed salary at or above $684 per week (the default minimum EAP level), with no allowance for nondiscretionary compensation paid at a later date, although nondiscretionary pay can be included in meeting the annual compensation requirement of $107,432 for HCE employees.

Employers are also allowed to make a final “catch-up” payment within one pay period after the end of each 52-week period to bring an employee’s salary to the required level for the EAP exemption. As noted above, employers would be required to pay exempt EAP employees at least 90 percent of the minimum salary level each pay period but could make up the shortfall in a catch-up payment in order to qualify the employee for the exemption. This catch-up payment may come into play if an exempt employee’s commissions, for example, are not sufficient to close the gap between the total amount of the guaranteed weekly salary the employee received and the total minimum salary level of $35,568 annually.

The 2019 Final Rule also increases the minimum total annual compensation for the HCE exemption from $100,000 annually to $107,432 annually. The DOL agreed with the concern of a multitude of commenters that by dramatically increasing the HCE exemption to $147,414 annually, as it had proposed in the Notice of Proposed Rulemaking, the DOL “would be imposing significant administrative costs on employers for a limited effect” because, despite the significant administrative burdens and compliance costs, the vast majority of current exempt HCE employees would remain exempt. The DOL, therefore, calculated the HCE threshold based on the 80th percentile of wages for full-time salaried employees nationally using pooled 2018/2019 current population survey data.

The 2019 Final Rule also revises the special salary levels for workers in U.S. territories and in the motion picture industry.

The DOL asserted its intention to update the minimum salary level for the EAP exemption and the minimum total compensation for the HCE more regularly in the future through notice-and-comment rulemaking, rather than through automatic increases. The effective date for the new minimum salary levels will be January 1, 2020.

What Employers Should Do Now

Employers should act immediately, as they have less than three months to review how the new salary levels will impact their business and their employees and to implement any necessary changes.

The first step is reviewing the salary levels of employees who are currently classified as exempt employees but who earn less than $35,568 annually—or, if the exemption is based solely on being classified as a highly compensated employee, earn less than $107,432 annual minimum compensation. Employers should require employees in this cohort to start keeping records of the hours they work each week. This information will allow employers to evaluate the comparative costs of paying those employees overtime premium pay or increasing the employees’ salary to the new minimum levels. Employers that are unable to increase payroll costs may need to limit the overtime hours worked by these employees and consider transferring some of their duties to other exempt employees earning above the new minimum salary level.

Employers may consider several strategies for implementing these changes:

  • For employees who will be converted from exempt to non-exempt, new record-keeping requirements will apply due to the new non-exempt classification. In terms of costs, however, the threshold issue will be whether the employee in fact works overtime with any frequency. For employees who routinely work no more than 40 hours per week, the change in classification may have minimal impact. Employers can also consider keeping those employees as salaried employees, rather than converting them to hourly workers. Employers are permitted to pay non-exempt employees a salary for the first 40 hours of work per week, and then calculate and pay overtime for any hours over 40 in a work week based on the employee’s regular rate for that week. This approach is often preferred for non-exempt employees who infrequently work overtime. The compensation such employees receive is the same as if they were paid on an hourly basis, but it may reduce some of the morale issues that can arise when a salaried employee is converted to an hourly employee.
  • For employees who meet the duties tests for an exemption, whose salaries are close to the new salary level, and who regularly work overtime, it may be most cost-effective for employers to raise their salaries to the new minimum salary levels. Employers should keep in mind that, if these employees receive nondiscretionary bonuses as part of their compensation, those amounts must be included in the regular rate of pay for non-exempt employees. (Note that, under the FLSA, nondiscretionary bonuses include those that are announced to employees to encourage them to work more steadily, rapidly or efficiently, if the employer has announced the method of calculation of the bonus, even if the employer retains discretion as to whether to pay the bonus.) Nondiscretionary bonuses will thus increase the overtime rate for work weeks that fall in the performance period on which the bonus is based. When the bonus is paid, the employer will also need to make a true-up overtime payment to cover overtime hours worked during that period. These compensation elements should be included in the evaluation of comparative costs of raising the salaries of affected employees to retain their exempt status versus converting them to non-exempt employees.
  • If it is too costly to have a junior or mid-level non-exempt employee work overtime, higher-level exempt employees may need to take responsibility for those work commitments. Employers must be careful, however, not to jeopardize the exempt status of those employees by diluting the exempt nature of their primary duties.
  • If the increase in minimum salary level will result in a significant number of employees becoming eligible for overtime, some employers may decide to bring on additional workers or redistribute work hours across current staff to reduce the number of employees who work more than 40 hours a week.
  • Employers may also choose to implement measures that increase the efficiency of their workplaces to cut down on the need for overtime. For example:
    • Reconsider frequent staff meetings that consume work time.
    • Evaluate whether travel to an in-person meeting is necessary or whether a video conference call or use of shared-screen technology may be sufficient.
    • Scrutinize whether and how many non-exempt employees need to participate in calls or meetings.

Finally, employers should also keep in mind that some states and localities, including California and New York state, continue to set a higher bar for exempt classifications under more stringent duties tests and/or higher minimum salary requirements. Employers must comply with both the FLSA and stricter state and local laws and ordinances for an employee to be properly classified as exempt. As a result, this new overtime rule will have relatively little effect on exempt classification in jurisdictions with more rigorous tests for exemption.